Starting an unincorporated company with one or more partners via an agreement is generally referred to as a partnership, in which each of the owners assume personal liability for the legal actions and debts of the entity (unless otherwise stated by law or within the agreement). Under this model, there are a few different formats that new business owners should consider before finalizing the agreement. Each format has implications, primarily revolving around the concept of liability, and choosing the right format for the needs of the partners is a critical starting point.
Types of Partnerships
For the purpose of this discussion, the most important types of partnerships to consider are general partnerships, limited partnerships, joint liability partnerships, several liability partnerships, and limited liability partnerships.
General Partnerships (GP)
This represents a default version of a partnership, which governs the relationships between the individual partners as well as between the partnership and the outside world. Each partner in the organization is considered an agent of the partnership, which means each partner represents the organization when dealing with external parties. Similarly, each partner has equal right to participate in the management, decision-making, and control (unless otherwise stated). Under most formats, adding a new partner requires the complete support and consent of all existing partners.
In terms of risks and returns (or liabilities and profits), the default assumption is that profits are distributed equally, and that liability is shared jointly and severally. Any debt or liability impacting the organization can be distributed equally (or via allocated responsibility) across the partners' personal assets.
Limited Partnerships (LP)
In a limited partnership, a general partner may collaborate with a limited partner. A limited partner has no managerial authority, nor in most situations would they earn equal returns. However, the limited partner is protected by limited liability in legal situations regarding debt or other costs that may impact the general partner's personal assets. Along similar lines, limited partners are not considered agents of the organization from a legal perspective. It is also important to understand that this is not the same as a limited liability partnership (LLP), in which all partners have limited liability.
Joint Liability Partnerships
Exactly as it sounds, a joint liability partnerships holds all partners equally liable for any financial and legal issues. As opposed to a several liability concept, in which liability may be distributed based on certain proportionate responsibility, joint liability partnerships are equal across the board. Picture a married couple purchasing a home. A joint liability on that loan would stipulate that both parties are equally responsible for repayment as well as equally in possession of the asset (i.e. the home).
Several Liability Partnerships
Several liability is the converse to joint liability, in which the involved parties will settle liability disputes based on respective obligations. This is easiest to demonstrate via an example. Assume two partners create a business, let's say exporting wine. Partner A is in charge of sourcing, getting great wine from around the world. Partner B is responsible for the buyer side, and ensuring legality with the countries they are selling too. While selling to a more conservative country, it turns out Partner B accidentally overlooked some legal steps in the importing process.
As alcohol can be legally complex with costly mistakes, and it was partner B's responsibility, it could be argued in a several liability case that partner B owes 80% of the cost for that mistake. To say 100% would likely be a little unfair, considering Partner A should be aware of the full channel. But how much liability does each party deserve? These are difficult questions, making this type of partnership slightly more complex.
Limited Liability Partnerships
Finally, there are limited liability partnerships (LLPs). In this situation, some or all partners have limited liability, which grants it some similarity with a corporation. LLPs do not hold each partner responsible for the financial and legal mistakes of the other partners. In some countries, LLPs must have a central GP with unlimited liability to put this risk somewhere (see limited partnerships). This format is quite popular among certain high-end services, such as law and accounting. It allows collaborative work while maintaining independence in regards to liability.
Like most legally complex concepts, in the United States in particular, LLP rulings can vary significantly from area to area. Understanding which liabilities are limited and which are not is important information to have before entering into a partnership.
Conclusion
When considering the appropriate type of partnership, liability is the key word. Prior to any formalized arrangement, each party should put forward their expectations concerning profit sharing and liability in clear terms. Aligning on the risk and return is the first step to moving forward in any professional business relationships at the ownership level.